There has been much hand-wringing over Dubai and other countries and their sovereign debt problems since the end of November.  There is a fear that the exposure of this debt might be the tip of the iceberg.  It is feared that the government debt crisis will spread from the small and traditionally weak and underfunded economies of Portugal, Spain, Greece, Italy and Ireland (the PIIGS) to the more substantial and traditionally strong economies of France, Germany, Japan and the United States bringing with it the fear of a global sovereign debt melt-down.  This opinion is emotional and uninformed

All the “sovereign debt default” talk about Dubai, Greece and Spain is old news that is just now getting press because what was already in motion at the top of the debt bubble in 2007 is finally coming to fruition.  Now that the commercial bank crisis has been for the most part averted, the sovereign debt issues that are closely related come to the fore. The Dubai problems were obvious two years ago or more. And Abu Dhabi and other UAE brethren have little patience for the profligacy of Dubai. They will backstop Dubai only after those who overextended get taken out. Then they will ride to the rescue and take control of many of the assets.

Same thing in Spain or Greece. Spain dug itself a deep hole by committing significant debt to aggressive expansion of public works, most notably the 3GW solar power expansion.  The EU will backstop those countries, but only at a price. It is in no one’s interest to let the fire burn out of control. I compare this to hot spots after a forest fire. If they don’t threaten to flare up and ignite new fires, you let them die out on their own.  Other times you douse them (with financial liquidity in this case) to put them out before they spread. If the infection spreads to Japan, that would be a much more serious event than Dubai, only because of the size of the Japanese economy and the relative importance of the yen. But I think the global central bank leaders have an eye on this and will prevent a Japanese economic collapse. As long as all major economies pull together, there is no reason to think we will have a financial calamity. Economic collapses require the public to panic (and stop spending). Panic is totally a psychological phenomena and can only be brought about by careless or reckless political actions (or inactions).

It is very important to note that the countries that are in danger of defaulting, are not key world economies. The talk of a major economic power like Germany, Japan or the USA being forced into insolvency is from someone ignorant of what it takes to force a financial default. Defaults don’t just happen, they are initiated by a creditor. If the debtor is large enough as compared to the creditor, then it is non-sensical or impossible for the creditor to force the default. The punishment will fall as much or more on the creditor as compared to the debtor. To force a smaller debtor to default, though, makes sense. Assets can be seized and held or resold to recoup the investment. Just who would force the USA, Germany or Japan into default? Who could gain? Who could manage the assets that were forfeited for the debt? There is no private money (hedge funds, ala John Paulsen) with the size to force a large sovereign to default.  China is the only creditor nation with the size to force such a default. But China won’t do it because it would be suicidal. China, the creditor, needs the developed world as much as the debtors need China and other developing, export-driven creditor nations. It is totally symbiotic, or co-dependent if one wants to be cynical about the situation.

To make my point about the relative size of creditors and debtors as it relates to default: I just made a good return recently on General Growth Properties (GGWPQ.pk) because I understood this dynamic. GGP was in technical default because of the financial crisis and its inability to roll forward short term debt taken on during the two to three years prior to the financial collapse. It was / is still cash flow positive and can cover the costs of its interest obligations, much like sovereigns with their ongoing ability to raise revenue from tax.  But GGP wisely had filed for bankruptcy as a single entity and had pulled all its various mall properties under the single corporate parent umbrella. This made GGP in effect, too big to fail. No single creditor had the legal power to force all the properties into a firesale. The court (Judge Gropper) saw it the same way and made the decision to force the parties to work out the mortgagtes (to refinance). When the creditors found out they were not going to be able to drive a hard bargain and take away the mortgaged property for much less than market value, they had to deal. Now GGP is close to exiting bankruptcy with all its property intact.

Even though sovereigns are unlikely to default in a cascading way, the global economy still remains weak.  It will take consumers and businesses a long time to regain their confidence to buy and bankers to lend.  For the overall American market, from this point on, the economy must improve significantly to get the SP500 much above 1200. But I think that is the higher probability over the next year or two as compared to a melt-down. Politically, I think President Obama is finding out that it isn’t prudent to be too anti-business. He seems to have finally gotten the point that the top priority is jobs. Health care and environment are lower priority since there is no money to pay for them if we don’t have near full employment and full tax revenues. We aren’t hearing too much health care talk from the Admin or Congress the past 2-3 weeks. To demonstrate his new-found love for business, Obama just had T-Sec Geithner spell out the capital gains tax freeze and investment tax credits for 2010. This will help jump start business and improve consumer sentiment as people start getting jobs.

As Obama and other world government leaders turn their attention towards restarting business, the world economy will heal and the markets will respond. Asian stock markets might be a little overdone just because of being the crowded trade, so I have backed off on them, for now. I have moved almost everything back to domestic large cap stocks or energy / commodities. I think 2010 will be a “consolidation” year with only a little index movement, maybe from 1100 to 1250. 2011 might be a similar year, with gradual improvement from 1250 to 1400. That would get us back to May 2008 which was about where the final dive started (down to 666). Maybe we pull back 100 points (10-12%) somewhere in the next 2-3 years. But by 2014 we can pass 1550 and set new highs, if the government continues to be supportive of business and doesn’t get too radical (seems more likely right now than 6 months ago).

I am buying up some of the banks that look like they are turning the corner and will be survivors. I have a bunch of the leveraged financial index, UYG, which is weighted towards the survivors like GS, JPM or WFC. But I also am buying some BAC now (as of two weeks ago). Even Citi might be a buy at this point, now that they have a plan to exit TARP. But I am passing on them for now.

Otherwise, my theme is Tech, commodities, energy and materials. Tech is due for a positive replacement / upgrade cycle after 10 years of being down.  Microsoft’s (MSFT) Windows 7 should be the catalyst in 2010 once the IT budgets are approved. Just buy the XLK if you don’t have any favorites. SMH is the semicon index which has more beta than the XLK. My favorites in commodities tend to the miners and energy stocks, though I have recently picked up some Potash (POT).  I also have call options on (FCX) and (BHP).  This is a better way to play the weak dollar trade than gold, in my book, as operating leverage contributes to performance and generates cash flow which actually has value to an investor.  They have all outperformed Gold in 2009.  Commodities and Energy will benefit from the global economic expansion that is the natural reaction to the collapse. I find it interesting that Suncor (SU) was going up the last two days while oil futures are going down. I find that a very positive sign. I have really loaded up on Pennwest (PWE) and Provident Energy (PVX) .

It has been a few weeks since the last post on the story of General Growth Companies and Pershing Square’s Bill Ackman. By all accounts, everything is going as originally speculated.

After a brief run to $3 per share, the stock has pulled back down to $1.65. This is not due to any fundamental change, but just the fact the buzz wore off the stock, temporarily. If anything, the recent court rulings and general improvement in the economy and banking sector bode well for General Growth. The objective of Pershing Square and most likely the bankruptcy court, is to buy enough time for the credit markets to thaw sufficiently that financing can be extended for the properties in question.

This is the conclusion of the attached presentation. The judge appears to be leaning towards a series of “cram downs” whereby the court will force the lenders to each property to extend terms of the mortgages and loans in such a way that both the lender and the borrower are made whole. This would be the ideal situation for General Growth and its shareholders as there might not be any dilution at all under this circumstance and no property liquidation.

I purchased more shares last week and will continue to add periodically as the story plays out and the prospects become clearer.

Here is a lengthy presentation on the status of GGP (now GGWPQ.PK as it trades OTC as a pink sheet) from Pershing Square in late May. Special attention should be paid to the financial models in the middle of the presentation. Ackman is using these same arguments in bankruptcy court in his role as largest individual shareholder and board director:

GGP Presentation 5.27.2009

We continue to monitor the events around General Growth Properties’ bankruptcy filing. It is one of the more fascinating corporate bankruptcies in many years.  The last we checked up on GGP in early May, Bill Ackman’s Pershing Square LLP with its 25% stake in GGP, had petitioned the court to be named to provide Debtor in Possession financing for the bankruptcy period.  This would have given Pershing Square the inside track on all the negotiations for the resolution of GGP’s bankruptcy.  Bill Ackman was on CNBC on Monday, May 11, discussing his stake and his interest in being DIP financier.  But Farallon was also interested and had made a better offer (lower interest rates / better terms) and eventually won that competition.

GGP subsequently was successful in bringing over 160 of its malls under the bankruptcy umbrella which gives equity owners a much better negotiating position as compared to the creditors / debt holders that are secured by that same property as Special Purpose Entities or SPEs. 

Here is the latest (last week) on General Growth Properties’ legal maneuverings:

CMBS Market OK with General Growth Rulings, so Far

By Al Yoon

NEW YORK, May 14 (Reuters) – Commercial mortgage bondholders took some comfort after a judge overseeing General Growth Properties’ bankruptcy stopped short of a move that they say would have undermined the structures of their securities.

The inclusion of more than 160 subsidiaries in the No. 2 U.S. mall-owner’s bankruptcy filing in April set off alarms in the commercial mortgage-backed securities market as investors feared a judge would consolidate the units. A consolidation would set a negative precedent in the market, where investors provide money with knowledge the assets are protected from events like bankruptcy at the parent or other units.

Judge Allan Gropper on Wednesday avoided taking steps toward a “substantive consolidation,” even as he allowed the company to garner cash flow from its disparate properties.

“We dodged this bullet, and I think everyone is breathing a sigh of relief,” said Richard Jones, co-head of Dechert LLP’s real estate group. “But this game is not over yet.”

A consolidation of assets under special-purpose entities (SPEs) could still occur as the company looks for leverage to fix the root cause of its bankruptcy: the inability to refinance debt, Jones warned.

Chicago-based General Growth GGWPQ.PK filed for bankruptcy after the credit crunch choked off financing for commercial property mortgages, challenging the company as it confronted maturities on billions of dollars in loans. Some three-quarters of its shopping malls joined in the filing, sparking industry concern.

CMBS provided more than $600 billion in financing for commercial real estate lending from 2005-2006, and the thawing of the market is seen as key for preventing a downward spiral of delinquencies and foreclosures.

“In general, (the judge) respected the SPEs,” said Christopher Hoeffel, president of the Commercial Mortgage Securities Association.

While inclusion of SPEs in bankruptcy is not ideal, the CMSA considered it a victory that Gropper maintained the isolation of the property assets, and put no additional liens on CMBS collateral, Hoeffel said.

Bondholders will continue to get principal and interest under the bankruptcy.

Many of the malls in the filing are top-quality, and their inclusion in the bankruptcy puzzled analysts. General Growth could be angling to use the threat of consolidation as leverage to get lenders and servicers to agree to restructure long term debt, Dechert’s Jones said.

A substantive motion can be made at any time during the bankruptcy case, he said.

Next up will be a May 27 hearing during which loan servicer ING Clarion Capital Loan Services LLC will argue that the eight malls it represents should be excluded from the bankruptcy. ING says that not only is each mall owned separately, but that all of them are current on their mortgages, with some having an ample cushion to pay. (Additional reporting by Ilaina Jonas; Editing by Leslie Adler)